Daniel R. Sanches

Money and credit with limited commitment and theft

We study the interplay among imperfect memory, limited commitment, and theft, in an environment that can support monetary exchange and credit. Imperfect memory makes money useful, but it also permits theft to go undetected, and therefore provides lucrative opportunities for thieves. Limited commitment constrains credit arrangements, and the constraints tend to tighten with imperfect memory, as this mitigates punishment for bad behavior in the credit market. Theft matters for optimal monetary policy, but at the optimum theft will not be observed in the model. The Friedman rule is in general not optimal with theft, and the optimal money growth rate tends to rise as the cost of theft falls.

Optimal Monetary Policy in a Model of Money and Credit

The authors study optimal monetary policy in a model in which fiat money and private debt coexist as a means of payment. The credit system is endogenous and allows buyers to relax their cash constraints. However, it is costly for agents to publicly report their trades, which is necessary for the enforcement of private liabilities. If it is too costly for the government to obtain information regarding private transactions, then it relies on the public information generated by the private credit system. If not all private transactions are publicly reported, the government has imperfect public information to implement monetary policy. In this case, the authors show that there is no incentive-feasible policy that can implement the socially efficient allocation. Finally, they characterize the optimal policy for an economy with a low record-keeping cost and a large number of public transactions, which results in a positive long-run inflation rate.

Private Money and Banking Regulation

We show that a competitive banking system is inconsistent with an optimum quantity of private money. Because bankers cannot commit to their promises and the composition of their assets is not publicly observable, a positive franchise value is required to induce the full convertibility of bank liabilities. Under perfect competition, a positive franchise value can be obtained only if the return on bank liabilities is sufficiently low, which imposes a cost on those who hold these liabilities for transaction purposes. If the banking system is monopolistic, then an efficient allocation is incentive-feasible. In this case, the members of the banking system obtain a higher return on assets, making it feasible to pay a sufficiently high return on bank liabilities. Finally, we argue that the regulation of the banking system is required to obtain efficiency.

On the Inherent Instability of Private Money

A primary concern in monetary economics is whether a purely private monetary regime is consistent with macroeconomic stability. I show that a competitive regime is inherently unstable due to the properties of endogenously determined limits on private money creation. Precisely, there is a continuum of equilibria characterized by a self-fulfilling collapse of the value of private money and a persistent decline in the demand for money. I associate these equilibrium allocations with self-fulfilling banking crises. It is possible to formulate a fiscal intervention that results in the global determinacy of equilibrium, with the property that the value of private money remains stable. Thus, the goal of monetary stability necessarily requires some form of government intervention.

Private Liquidity and Banking Regulation

We show that the regulation of bank lending practices is necessary for the optimal provision of private liquidity. In an environment in which bankers cannot commit to repay their creditors, we show that neither an unregulated banking system nor narrow banking can provide the socially efficient amount of liquidity. If the bankers provided such an amount, then they would prefer to default on their liabilities. We show that a regulation that increases the value of the banking sector’s assets (e.g., by limiting competition in bank lending) will mitigate the commitment problem. If the value of the bank charter is made sufficiently large, then it is possible to implement an efficient allocation. Thus, the creation of a valuable bank charter is necessary for efficiency.

ADVERSE SELECTION, SEGMENTED MARKETS, AND THE ROLE OF MONETARY POLICY

A model is constructed in which trading partners are asymmetrically informed about future trading opportunities and spatial and informational frictions limit arbitrage between markets. These frictions create inefficiency relative to a full-information equilibrium, and the extent of this inefficiency is affected by monetary policy. A Friedman rule is optimal under a wide range of circumstances, including ones where segmented markets limit the extent of monetary policy intervention.

On the Welfare Properties of Fractional Reserve Banking

Monetary economists have long recognized a tension between the benefits of fractional reserve banking, such as the ability to undertake more profitable (long‐term) investment opportunities, and the difficulties associated with it, such as the risk of insolvency for each bank and the associated losses to bank liability holders. I show that a specific banking arrangement (a joint‐liability scheme) provides an effective mechanism for ensuring the ex post transfer of reserves from liquid banks to illiquid banks, so it is possible to select a socially efficient reserve ratio in the banking system that preserves the safety of bank liabilities as a store of value and maximizes the rate of return paid to bank liability holders.

Can Currency Competition Work

Can competition among privately issued at currencies such as Bitcoin or Ethereum work? Only sometimes. To show this, we build a model of competition among privately issued at currencies. We modify the current workhorse of monetary economics, the Lagos-Wright environment, by including entrepreneurs who can issue their own fiat currencies in order to maximize their utility. Otherwise, the model is standard. We show that there exists an equilibrium in which price stability is consistent with competing private monies, but also that there exists a continuum of equilibrium trajectories with the property that the value of private currencies monotonically converges to zero. These latter equilibria disappear, however, when we introduce productive capital. We also investigate the properties of hybrid monetary arrangements with private and government monies, of automata issuing money, and the role of network effects.

ON THE WELFARE PROPERTIES OF FRACTIONAL RESERVE BANKING: ON THE WELFARE PROPERTIES OF FRACTIONAL RESERVE BANKING

Monetary economists have long recognized a tension between the benefits of fractional reserve banking, such as the ability to undertake more profitable (long�?term) investment opportunities, and the difficulties associated with it, such as the risk of insolvency for each bank and the associated losses to bank liability holders. I show that a specific banking arrangement (a joint�?liability scheme) provides an effective mechanism for ensuring the ex post transfer of reserves from liquid banks to illiquid banks, so it is possible to select a socially efficient reserve ratio in the banking system that preserves the safety of bank liabilities as a store of value and maximizes the rate of return paid to bank liability holders.

Banking Crises and the Role of Bank Coalitions

The goal of this paper is to provide a framework to analyze the effectiveness of bank coalition formation in response to an external aggregate shock that may cause disruption to the payment mechanism and real economic activity. I show that the kind of insurance mechanism provided by a specific type of bank coalition allows society to completely prevent any disruption to real activity that can be caused by a temporary drop in the value of banking assets, at least in the case of a shock that is not too big. If the shock is relatively large, then a private bank coalition will be unable to completely prevent a disruption in real activity even though it will be able to substantially mitigate the effects on equilibrium quantities and prices. Thus, the existence of a private bank coalition of the kind described in this paper can be an effective means of preventing significant disruptions in trading activity.